Do Your RSUs Expire? What Happens to Unvested Stock

Restricted Stock Units (RSUs) are a common form of equity compensation offered by companies. These units represent a promise from an employer to deliver company stock or its cash equivalent to an employee at a future date. RSUs do not “expire” like options; instead, they either “vest,” meaning the employee gains full ownership, or are “forfeited,” meaning they are lost, based on predefined conditions. This ownership is contingent upon meeting specific criteria over a period of time.

Understanding RSU Vesting

Vesting is the process by which an employee gains full ownership of their Restricted Stock Units. Until RSUs vest, they are not considered owned by the employee and generally hold no voting rights or dividend entitlements.

There are two common types of vesting schedules: time-based and performance-based. Time-based vesting grants ownership over a set period, such as 25% of the RSUs vesting each year over four years. This can include “cliff vesting,” where a significant portion vests after an initial waiting period, typically one year, followed by incremental vesting. Alternatively, “graded vesting” involves incremental vesting from the start, with portions becoming owned at regular intervals.

Performance-based vesting makes ownership contingent on achieving specific company or individual metrics, such as revenue targets or project completion. The specific terms governing vesting are detailed in the employee’s RSU grant agreement.

Scenarios Leading to Forfeiture

While RSUs do not expire like options, they can be forfeited, meaning they are lost before vesting. The most common scenario for forfeiture is the termination of employment.

If an employee resigns or is terminated, any unvested RSUs are typically forfeited and revert to the company. However, vested RSUs are generally retained by the employee. For performance-based RSUs, failure to achieve stipulated performance metrics, such as company goals or individual targets, will result in forfeiture. Less common scenarios, such as company dissolution, bankruptcy, or certain change-of-control events, can also lead to the forfeiture of unvested RSUs, depending on the terms outlined in the grant agreement.

Taxation of Vested RSUs

The vesting of Restricted Stock Units is considered a taxable event. When RSUs vest, their fair market value at that time is treated as ordinary income for the employee. This amount is added to the employee’s taxable income for the year and is subject to federal, state, and local income taxes, as well as FICA taxes (Social Security and Medicare).

Employers typically withhold a portion of the vested shares or cash to cover these tax obligations. For federal income tax, a common withholding rate for supplemental income, which includes RSU income, is 22% for amounts up to $1 million, and 37% for amounts exceeding $1 million. However, this withholding may not cover the employee’s full tax liability if their effective tax rate is higher, potentially requiring additional tax payments. The fair market value of the shares at the time of vesting becomes the cost basis for capital gains tax purposes when the shares are eventually sold. This income, along with the taxes withheld, is reported on the employee’s Form W-2.

Managing Vested Shares

Once Restricted Stock Units have vested, they convert into actual company shares and are typically deposited into a brokerage account designated by the employer. The shares are fully owned by the employee and are considered standard shares of stock.

Employees have several options for managing these vested shares. One option is to hold the shares, which makes the employee a shareholder in the company and allows for potential future appreciation or depreciation, as well as eligibility for dividends if the company pays them. Alternatively, an employee can choose to sell the shares immediately. This often involves a “sell-to-cover” transaction, where enough shares are sold to cover the tax withholding if not already handled by the employer, or a “sell-all” approach to diversify holdings or realize cash. Decisions regarding holding or selling shares should align with individual financial goals and broader diversification strategies.